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Academic Research Against Discount Rates

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There are other reasons why we do not consider the future. For example, for the last few decades economists have pretended it does not exist. They use a method called discounting to evaluate all future consequences of current behaviour with aim of ascribing to that future a value in the present. They do this by literally ‘discounting’ the financial consequences of those decisions to the present using a risk weighted interest rate. It is claimed that this produces objective current decision making. Supposedly rational organisations use this approach, accepting its implicit assumptions.

Discounting does, of course, have two meanings. One is to discount – to not count. The other is to adjust a value for some combination of time, risk and so on so as to give us a current value of some future.

The second is a way of considering the future. Not, as the man who is a professor of economics three times over thinks, a manner of not considering the future.

This is just him – again – not understanding the basics of the subject he wishes to opine upon. The inverse of a discount rate is an interest rate. The existence of the latter demands that the former exist. His bonds will pay interest – therefore he’s already sold the pass about whether there should be a discount rate. But he’s too lightly versed in the subject under discussion to grasp that.

The other is that we are actually indifferent as to when things might happen. This is much more troubling. What the theory of discounting implies is that I am indifferent between a relatively modestly good thing happening in a year’s time compared to a monumental event in ten or more years time, presuming the assumed discount rate can literally equate the two to a similar value now. And that is just not true either.

He really needs a bit more versing in this. Say, the Stern Review’s – or the Dasgupta – on this. How does Stern reach his discount rate? Well, he points out that asteroids have been known to hit the Earth and wipe out species. Could happen again. Therefore there’s always a chance – a chance only – that we get dinosaured before we manage to boil the oceans. Thus we must actually use a positive discount rate because there’s always that risk that even if we entirely control climate change there’s still that possibility that current sacrifices would have been in vain.

It’s worse than that, in fact. The mathematical model can provide a perverse incentive to delay, by diminishing future cost and so enhancing current supposed well-being by simply pushing back the time when a required action takes place, when in practice we know that taking action now really is a matter of the highest priority if the goal is to be achieved.

That’s a matter of the choice of your discount rate. Use a lower one – as Stern does – and the validity of action now is increased.

The argument about delay is not that future cost is diminished. Rather, that we’re in a world where technology advances. Therefore – possibly at least – the cost of a solution declines over time even as the disaster comes closer and thus more expensive. It’s something of a balancing act to decide when to deploy our advancing technologies so as to gain the optimal result. Deploy too soon and we do so at too high a cost because we could have waited and used the cheaper solution. Deploy too late and of course we lose more from the damage than we do the cheapness of the now developed technology.

Think through this for a moment. Imagine we all had got really serious about abolishing the use of fossil fuel in the 1980s when St. Maggie first started noting it. That would mean trying to heat our homes with 1980s efficiency and expense solar panels, with 1980s efficiency windmills. We’d be both broke and cold as a result. Now, in the 2020s, we’re at least told that they are cheaper than the alternative technologies. So, which is cheaper? Delay to when the technology is cheap enough? Or do it immediately?

Now make the same logic ridiculous. Should we not have started to use coal in London in 1306 because it was going to cause a problem in 2056? You know, how much delay should we have used?

And this is also true of climate change. There discounting cannot work. It encourages deferred action when what is required is current activity if this crisis is to be beaten.

How is it that one bloke in Ely has had the revelation that escapes the entire economics profession? The value of doing something now about future problems is diluted by how far away and how likely that problem is. This is not difficult to understand, is it?

The means to address this false logic of discounted decision making are the focus within the Time Mirror academic project, funded by the Danish government, in which I am taking part over the next four years. Explicitly exploring the idea of sustainable cost accounting, which I have created, as a means for addressing this issue the project will look at why discounting would hinder effective accounting decision making on climate change, not least within the private sector economy where a massive behavioural transformation is very clearly required.

You what? We’re going to start using accounting information without discounting? Eh?

Sustainable cost accounting demands that companies put the costs of achieving net carbon zero on their balance sheets upfront. It challenges the logic of not disclosing the potential costs upfront and in full, and accounting for them on a deferred, drip feed, basis instead. It says that in this case the future must be addressed now by provisioning on company balance sheets the full expense thought likely to be incurred and that the plan for action must be explicit in the present, even if it can only occur in the future, at which point outcomes against stated expectations must be compared and consequences be accounted for.

Well, isn’t this interesting. So, OK, take the proposal. It will cost Rolls Royce $50 billion to change jet engines to work on biofuel – just as an entirely made up example. That’s at $5 billion a year for the next decade. Great. So, what’s the balance sheet charge then? $50 billion? Or $5 billion in year one, $4.950 billion in year two and so on? We putting an interest rate in there or not?

Or, even, work this the other way around. To meet a $50 billion expense Rolls Royce has to raise how much new capital today? If it raises $50 billion but spends it over a decade then it will be earning interest for a decade – logically, on half the sum. $25 billion for a decade at 1% (just, say) is $250 million. So, does RR have to raise $50 billion or $49,750 million?

Obviously, only the smaller sum. Which is discounting, you fool.

The logic says that you cannot discount the future in the present.

Idiocy, just flat out damn fool idiocy. The cause, again, being the entire lack of knowledge of the subject he wishes to discuss. Take this from Sir Partha Dasgupta:

Still, we may at least ask for consistency in our decisions. Forget about global warming and consider the much simpler problem of economic growth. How much should we save today to bequeath to future generations if we really believed in a 0.1 percent social discount rate and the other assumptions built into the Stern model? The answer, according to Sir Partha’s calculation, is that we should invest 97.5 percent of what we produce today to increase the standard of living of future generations.

Sir Partha’s stripped-down model leaves out uncertainty, technological change and population growth, but even so, such a high savings rate is totally implausible.

Actually, that’s Hal Varian (the economist at Google) talking about Sir Partha but you get the point. Even using a low discount rate gives us absurd answers and using none at all gives us simply wrong ones. If something that happens in 100 years is to be given the same, undiscounted, value as something that happens now then we should be investing everything in that future. We have no mechanism left of allocating costs and benefits over the uncertainties of time.

It’s simply insane.

Embracing the future has massive current consequences. It is what we need to do, but we are so poor at thinking about the future as a result of the training in indifference that we have been given that we, and most especially our politicians, rarely take into account foreseeable events that might happen in only a few months time, and literally discount them instead. And that is both shocking, and as we now know, deeply costly.

This sort of thinking only comes about because of deep, deep, ignorance of the subject under discussion. But then this is Richard Murphy……

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